The alleged savior of the Australian economy, and by implication, our share and property markets, has been our rampaging northern neighbor and now largest trading partner, China. Conventional wisdom appears to suggest that with a rapidly urbanising population and a billion cheap workers, the China story is far from over. However, a growing chorus of sceptics are questioning whether China’s insatiable growth is sustainable, or even real.

One of the world’s most well-known (and most successful) bears is hedge-fund manager Jim Chanos. Described by the New York Times as “America’s Pre-Eminent Short-Seller”, Chanos runs Kynikos Associates (which is Greek for cynic) and is most famous for being one of the first to “short-sell” Enron and Tyco. Chanos makes money (and a lot of it, some claim he is a billionaire) by selling companies that he believed have been overvalued by the market. In 2007 (only months before the credit crunch), Chanos dubbed Macquarie Bank his “number one short sell” due to the bank’s unsustainable business model (Chanos correctly opined that the Macquarie model “only works in a world of cheap credit and asset inflation”. Chanos was eerily prescient, despite Macquarie’s now laughable denials.

In January, Chanos focused his criticism on China, claiming that  “China has embarked on a capital-spending bubble the likes of which the world has never seen … buildings are going up with no tenants, roads are built with no traffic, shopping centres are built with no tenants or customers, yet they continue to be built and they continue to be planned … China is Dubai times 1000, if not a million … at some point, all of this (ill-advised) investment will come home to roost.”

Chanos’ criticism is not without foundation. China’s economy remains heavily planned and its economic data untrustworthy. It is difficult to take seriously China’s claims of third quarter economic growth of 8.9%. As Chanos claims, China, like his other great prey Enron, is very much a “trust me” story. China is asking the world to trust it — trust that its $US900 billion ($A974 billion) stimulus was effective, trust that its growth rate remarkably tends to end up about 8% quarter after quarter, trust that a tightly run planned economy with a questionable human rights record could be more successful than a free-market based democracy.

Even worse, China’s property and share markets have turned into a giant craps shoot. While gambling may not be legal in China, investing in the Chinese share market appears to be a pretty good proxy. Last year, while world market struggled to recover losses, China’s Shaghai exchange rose by 70%, while its Shenzhen bourse rocketed by 105%. Bill Powell wrote in Fortune last month that:

Most stocks listed in Shanghai and Shenzhen are open only to Chinese investors (though foreigners can invest directly in a more limited number of companies through the thinly traded B share class).

Meanwhile the Chinese — with their famously high savings rates — have limited opportunities to put their money to work abroad. So the homegrown market is effectively a closed shop.

Banks pay almost no interest on deposits in China, which pretty much leaves equities and real estate as the two main investment options for retail investors. And institutional fund management is still very small.

So rather than being guided by large shareholders that crave stability, the stock markets are dominated by skittish amateurs.

China’s property market is little better. The Financial Times reported that house prices accelerated a further 7.8% in December compared with the previous year with new loans doubling in 2009 as the Chinese government ordered banks to support flagging growth. The FT claimed that “most analysts and a growing chorus of developers say a bubble has already formed in China’s property market, driven mostly by a surge of easy credit pumped into the economy by state-owned banks during the year”.

Of course, there are also no shortage of people who do seem to trust China, claiming that China’s bubble is far from popping. Most notably, long-term, China bull (and commodities guru) Jim Rogers (who co-founded George Soros’ Quantum fund),  was critical of Chanos, telling the New York Times that “I find it interesting that people who couldn’t spell China 10 years ago are now experts on China … China is not in a bubble.” Admittedly, Rogers told Bloomberg that he hasn’t “bought any Chinese stocks since November and haven’t sold anything either … I’m waiting for cheaper prices. I’m not buying Chinese at these levels.”

Others point to China’s burgeoning savings and the higher amounts of equity, which Chinese property buyers are required to utilise (according to Forbes, China allows loan-to-valuation ratios of 70% for a residence and 50% for an investment property) or the different ways in which China accounts for income.

However, while the China bubble could continue for months or years to come — a planned economy not known for human rights and  continuing to defy gravity would also need to defy history.

Peter Fray

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